Last week we discussed the short case for Herbalife from the perspective of Ackman who has been pounding the table that the company is a giant pyramid scheme. The main concern with his argument is that the data from Herbalife dealers and buyers is not there to support it.
While the case is compelling and he has rallied other investors, raised concerns from certain organizations, and even roused some in government, no definitive evidence has emerged. In fact, Herbalife (NYSE: HLF) stock has rallied since the short case was initially made and investors like Carl Icahn have had great returns on their investments.
Belgian Ruling Positive for the Company
This week, there was some positive news for Herbalife on an investigation into the company as a pyramid scheme. The Belgian Court of Appeal reversed a previous ruling by a lower court that the company’s sale model is in compliance with Belgian law. A previous judgment that the company was operating a pyramid scheme was reversed. Management states the company always believed the ruling would be reversed and that it was based on factual errors.
As a result of the ruling, the stock jumped to new highs:
Speculation That Icahn Will Reduce His Position
Also this week, the investment of Icahn has come under increased interest and speculation that he will sell, which could weigh negatively on the shares. Herbalife issued a statement that it is not aware of any plans by Mr. Icahn to reduce his position in Herbalife, which through its mere issuance indicates at least some on Wall Street expect it.
Icahn held 17% of the outstanding shares as of September 30, 2013 and requires a volume-weighted average of $73/share for five consecutive days in order to sell. He also had the ability to sell after February 28, 2014 but the former of these two provisions was met earlier this week. He has over a 200% return on the investment in Herbalife, and many investors would lock in some gains at this point.
The question is: how much will he lock in? To answer that we must look at the prospects for the stock and company over the next 12 months.
Global Expansion Provides Fundamental Case to Buy
The global expansion of Nutrition Clubs have pushed the shares higher in 2013 and will continue to act as the primary driver of fundamental growth. In South America, volumes increased by 32% in Q3 2013. In China and EMEA, volumes were up by 71% and 19%, respectively. The opportunity in the emerging markets is significant according to management. Rising incomes and lifestyles, and a lack of a significant retailer presence for quality nutritional supplements and vitamins, results in an underserved market that fits perfectly into Herbalife’s business model.
In addition, the U.S. market continued to grow at 10% despite some negative headlines on the company. The positive U.S. results were driven by the improved recruiting trends. The company’s growth rate in the U.S. could accelerate further if the investigations and pyramid accusations are put to bed. This, along with international growth, could deliver revenue growth in the mid-to-upper teens for Herbalife.
Valuation Indicates a 10 to 15% Overhang
Management also guided for 2014 sales growth in the 9 to 11% range and for EPS of $5.45 to $5.65. Current EPS consensus for 2014 is for EPS of $5.73 and EBITDA of $950 million on sales of 5.25 billion dollars. The stock currently trades at 13.3x FY14 consensus earnings.
Tupperware, which also distributes its product in a similar manner, trades at 14.9x FY14 EPS. On an EV/EBITDA basis, Herbalife trades at 9.3x versus Tupperware’s 11.7x TTM.
There are some clear warts on Herbalife and its stock, mainly the lack of audited financials that were promised at the end of September and the ongoing SEC investigation that started early this year. There is the potential that both of those are resolved and two more overhangs are removed from the stock. In particular, the audited historical financials are expected from PwC over the next month. However, it is possible that those, and/or the investigation, go against the company, and at least remain headwinds.
There is a discount implicit in the share price of Herbalife behind the pyramid scheme accusations. If these concerns are largely put to rest, there is probably upside to Herbalife shares to the range of $85 to $90 based on the overhang being removed. In addition, it could also help sales growth accelerate in the U.S. with that headwind removed leading to an acceleration in EPS growth and further multiple expansion. On the other hand, if the accusations are even partially confirmed at this point, there is very significant downside risk. The shares could quickly get cut in half.
For investors, this is a stock that requires doing as much homework on sales as possible. That may mean actually talking to some dealers and distributors and getting a feel from them. If through this and other analysis, the pyramid scheme case does not appear to be supported, then buy the shares.
What are your thoughts on the revelations this week in Europe and the potential impact on the investigation? Are you a buyer or seller?